governance, political economy, institutional development and economic regulation

The embattled Finance Minister Arun Jaitley – clearly aware that the knives are out for him

Finance minister Arun Jaitley will be fighting from a tight corner on February 1, 2017, boxed in by low domestic demand and the approaching international headwinds of a protectionist United States.

Fighting on the backfoot is new to this government, which had it easy over the first two years. The windfall from falling oil and commodity prices created fiscal space over the last two years to check the right boxes on fiscal deficit and inflation. High interest rates kept the rupee strong. Deft footwork also boosted GDP numbers since 2014 to signal a new age of high economic performance.

Here are six red flags, which track if the finance minister’s courtroom fighting abilities are still intact as he presents Budget 2017-18.

Does the growth estimate triangulate?

The estimate for growth during the current year 2016-17 and 2017-18 will show whether the government recognises that it has a problem. Assumptions of unrealistically high growth have a domino effect. They reduce the credibility of the tax revenue projections and the size of the fiscal deficit both of which track GDP growth. GDP growth estimates above 10 per cent in current prices (corresponding to six per cent in constant prices) or a number higher than Rs 149.5 trillion for 2016-17 and above 10.5 per cent in current prices (corresponding to 6.5 per cent constant prices), for 2017-18 is a red flag showing the government is burying its head in the sand.

Do the tax revenue estimates sound real?

An estimate for gross tax receipts, including the share of the states in Centrally-levied taxes, higher than the 10.8 per cent of GDP budgeted for in 2016-17 is unrealistic. Sticking to this level may be termed not aggressive enough in the context of the hyped-up expectations from the attack on black money. But note that this level was previously last achieved seven years ago, in 2007-08 before the financial crisis. Now, with fresh uncertainties in demand and corporate profitability, it remains an aggressive target. Anything higher is dodgy.

Any incentives for tax compliance?

Assuming higher average revenue from increased indirect tax rates, when the Goods and Services Tax rates have still to be negotiated with the states, give the wrong signals for growth, business and private consumption. On direct tax, some fiscal courage is required. Dilute the disincentive to evade tax, inherent in high tax rates — currently between 10 to 30 per cent — for middle-income earners up to an annual income of Rs 24 lakhs. It is reasonable to expect that better compliance will compensate for the hit taken on lower tax rates. Not doing so flags low confidence in the responsiveness of the tax machine to broaden the tax base. Challenging the machine to do better can work. Try it.

Are there band aids for the victims of demonitisation?

Economic shocks affect the poor the most. Eighty per cent of the poor live in rural areas. The bottom 40 per cent of the population are either poor — a constantly changing group averaging around 22 per cent of the population — or are non-poor but vulnerable to fall into poverty due to personal or systemic shocks.

The allocation for rural poverty alleviation in 2016-17 is Rs 0.6 trillion across four schemes. The ongoing National Rural Employment Guarantee Act (NREGA) is a second best but a practical, quick-start option to scale up income transfer to the poor to insulate them for the twin economic shocks.

NREGA operates in all the 707 districts of India. This is politically sensible but wasteful. Out of the 29 states there are nine states in which the proportion of the poor exceeds the national average of 22 per cent. These “stressed states” should be specifically targeted. Separately, the government should target 40 per cent of the poorest districts, using the “poverty gap/person equivalent” metric to ensure that there is an incentive to first transfer income to the poorest of the poor. Anything less than an enhanced outlay of Rs 1 trillion for poverty alleviation red flags an irresponsible development strategy.

Has the fiscal deficit become an unreal holy grail?

Mr Jaitley has been steadfast in lowering the fiscal deficit from the level of 4.3 per cent in 2013-14 — the terminal year of the previous government. He courageously embraced the daunting target of 4.1 per cent, naughtily left for him to deal with by P. Chidambaram in the interim Budget for 2014-15.

He succeeded in meeting the target against all expectations. But he was subsequently, practical enough, to retain a target of 3.5 per cent of GDP for 2016-17 instead of the planned three per cent. Inflation is currently low, at well under five per cent per year — the target level determined in the monetary policy framework. The US generated economic shocks to world trade; to growth and to world demand will keep commodity prices low.

It is good to recollect that the fiscal deficit peaked at 6.5 per cent in 2009-10 soon after the financial crisis of 2008. We are yet again in a perfect storm of domestic and external shocks. The need of the hour is to be practical not foolhardy. If the finance minister chooses valour over vision and sticks to a fiscal deficit target of three per cent for 2017-18, the red flag of fiscal cowardice should go up. The brave accept challenges and fight them openly.

Has public investment been provided for?

Sluggish private investment requires that the slack be met by public investment. Banks are to be recapitalised, infrastructure developed and armaments upgraded. 2016-17 targeted 1.6 per cent of GDP for Central government investment expenditure. Budget allocations have always trailed actual investment expenditure so there is room for some bravado here. The investment red flag must be raised if targeted investment in 2017-18 is below two per cent of GDP.

To navigate the dragnet of stagnant tax income, lower growth and low demand, the finance minister must avoid raising any of the six red flags. To do so, he must systematically cut waste and pork to balance the Budget transparently.

Pushing for doubling revenues from privatisation to a never-achieved estimate of Rs 1 trillion is one button he should press for increasing the fiscal leeway available to him. This will also signal that the reform process is alive and well. There is nothing like a resource constraint to separate the winners from the also ran.